When do you recognize bonus expense when company grants a retention bonus payable 75% in year 1 and 25% in year 2 with clawback provisions?
Retention Bonus Accounting
Answers
Is the bonus earned like a percentage of completion so that each month the stays they earn a portion of the bonus or is it all payable 75% at the end of Year 1 and 25% at the end of Year 2?
In either instance, I think I would accrue a portion of the bonus each month.
It really depends on the language of the agreement. Clawback provisions, aside, you would book the expense when the bonus has been earned by the person. If they need to be there on Dec 31, 201x to get the bonus you would record that portion (75%) on Dec 31, 20x1. The other 25% would be recorded on Dec 31, 20x2. The clawback may give you pause to say that you don't have a liability until the clawback provision is satisified (Dec 31, 20x2) but since it is really hard (nearly impossible) to enforce clawback provisions from a practical (and sometimes legal) standpoint, most people will argue that you recognize the expense in the period when the bonus was earned and then worry about a clawback if and when that happens. Good Luck
I would add the actual amount of the accrual could be trued up depending on the run rate of achieving the performance levels tied to the cash incentive (e.g. payout at threshold 50%; or closer to cap of 150%) driven by the design of the plan. Monthly true-ups is common; in some organization could be quarterly.
The very simple answer is the bonus is a liability you owe, independent from when you pay it out. I would book the expense monthly as earned based on assumption of the staff achieving 100% for the year, and credit the amount to a bonus liability account for pay out.
I would true up the liability account quarterly based on the claw back provisions with one very specific caveat: be careful to have enough checks and balances in place to ensure the individuals creating the true up calculations understands that this account could be used to create large credits or debits to the bonus expense and be used to manipulate the quarterly operating income. You are going to want to implement multiple approval, consistent true up calculations that can be easily explained, justified, and audited.
Err on the side of caution. You do not want to underfund the liability account.
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In my experience the retention bonus was devised as we were spinning of the divisions and needed the execs to stay. There are lots of hurdles to selling a business- most nothing to do with the retained exec. Based on my experience I would recognize the liability and front end the charge to the P&L. Clawbacks are rarely triggered and usually cost a significant legal sum to enforce so they should be ignored.
Of the answers above, I believe Ted's addresses this best. However, you could record the expense pro-rata over the period (year) rather than taking a large charge on December 31.
I agree with Ted. Unless there is a provision in the agreement that give a portion of the retention bonus for every month worked, with the full payment at XX date, the expense should be taken when the bonus is paid, not accrued over a term. If the person leaves before that date, the assumption is that no bonus will be paid out, therefore no bonus was earned and no expense should have been taken.
The expense should be accrued monthly, and trued up or reversed as necessary. For any bonus or incentive plan you wouldn't wait until the payment is made to recognize the expense.
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Correct - the assumption is that the employee will stay, so the entire retention bonus should be expensed ratably over the retention period. Assuming that there is a valid reason for a higher payment in year 1, I would expense the year 1 (75%) payment ratably during year 1 and the year 2 (25%) payment ratably over year 2. If the employee leaves prior to earning the full bonus, then the expense would be adjusted.
While you have lots of opinions, I would expense each part ratably over the retention period - 75% in year one and 25% in year two. If the retention also includes some performance level that must be attained, you would make a judgement on the probably of it being attained and adjust the monthly expense accordingly.
It is frankly a bit discouraging to see how many senior finance people answered this incorrectly. Ted's answer may be fine for a private company without a quarterly SEC filing, but is absolutely unnacceptable for a public company. The FASB as well as the SEC (through comment letters) have been very clear - when it comes to ANYTHING related to compensation, the expense associated with that compensation should be recorded over the period the service is rendered. It is not accepable to record as a lump sum when the milestone is reached, unless of course you assess the likelihood as being less-than-probable (which is an unlikely assessment). It doesnt matter that it isnt legally earned ratably. If the people leave 11 months in, then you will get the credit back.
If you had a large group of employees, you could of course layer in a turnover rate, but if it is a small group it is likely safer to amortize the entire expected payment.
Keep in mind when I say amortize, I mean within the milestones, not over the entire amount. You always have to expense at least as much as has been earned legally. So, in summary, Jack Rudd's answer is correct, 75% ratably over the first period, and 25% ratably over the second period.
Apologies for posting anonymous - company policy on opinion web postings.
(AVP, Corporate
I second that.
The correct US GAAP answer is ratable over the service period (during which it is earned, during which the company receives the benefit). In this case 75% should be accrued ratably over year 1.
Assumptions for plans with performance clause: liability is probable.
Large pool assumption: recognize amount net of estimated forfeitures.
Change in Estimate
Search for "compensation" in FASB Codification.
Interesting answers, however the clawback provision makes a whole different ballgame. The addition of the clawback creates an embedded derivative and must be accounted for in that manner. You must create a decision tree with the probabilities for the net bonus payouts by year, by person. Then, by multiplying the probabilities by the payout, by the present value and adding them all together you will get the liability to post on the B/S. Yes, it is fictional, but that's the way FASB wants it.
Good luck
In a small company with a couple execs on a retention bonus it is unlikely that the agreement warrants derivative accounting. These are typically written after a negotiation with mutual understanding of what will happen. The probability of payout is 100% and probability of clawback is 0%, until something to the contrary becomes evident. If you roll that to 100,000 employees, then you'll get into modeling scenarios, quarterly.
Example 1: A founding exec tells the board he wants to retire. The board gives him 2X his salary to stick around for a year. He Will stay.
Example 2: the job market is hot, so the company gives 100 of its mid level employees a 5% retention bonus to stay for a year. Probability of forfeiture is pretty high, anyone who can get a better job will, and 5% bonus will not stop them. So you'd bake in the forfeiture assumption into your calculation.
And so forth, the bigger the pool, and the more conditions, the more complex your model will become. In the end you accrue your best estimate of the amount ultimately expected to be paid out, ratably over the requisite performance period, but not less than what is considered legally earned at the end of any given reporting period.
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Human Capital